Accounting for self-constructed fixed assets
January 15, 2013
Companies may build (construct) some of their fixed assets because such assets may not be available for purchase from other companies or because it is cheaper to do so. An important aspect of constructing own assets from the accounting standpoint is the cost accumulation. In this article we will discuss which expenditures should be included in the cost of self-constructed assets (interest capitalization is not covered in this article).
When a company self-constructs an asset, there are direct and indirect costs (overhead), which should be included in the cost of the asset.
Direct costs are usually easily identifiable and can be traced to the asset directly. For example, when a company builds a new piece of manufacturing equipment, the cost of construction materials used to create a platform for the equipment, wires and other parts used to build the electrical system, and purchased parts are added to the cost of the equipment. Invoices, bill statements, etc. can be used as source documents for such costs. Likewise, payroll and benefit costs related to the employees directly involved in the construction of the equipment are included in the equipment cost. Payroll reports can be used for payroll and benefits related costs. If employees work on several projects (e.g., several pieces of equipment), their payroll and benefit costs should be allocated to each project using labor hours (in this case time reports / cards can be used for the allocation).
Indirect costs (overhead) may be more challenging to allocate and US GAAP doesn’t have specific guidance as to how such costs (if any) should be allocated to the cost of a self-constructed asset. One approach may be to allocate indirect costs based on a direct cost (e.g., labor hours of employees involved in the construction project). Indirect costs may include screws, depreciation of assets used in the construction, etc.
Indirect costs should be distinguished from general and administrative costs. General and administrative costs are considered period costs: this means they are expensed in the period they are incurred; and as the result, general and administrative costs are not included in the cost of self-constructed assets.
It is always advisable that management prepares an internal policy that spells out how (e.g., allocation) and what (e.g., direct, indirect) costs should be capitalized in self-constructed assets. This policy should be followed consistently.
The cost accumulation continues during construction in a construction-in-progress general ledger account. This is a fixed asset account with no associated depreciation because construction in progress is not depreciated. When self-constructed assets are completed (e.g., testing has been performed and Engineering Services approved putting the assets in service), the accumulated cost of the assets is transferred into fixed asset account(s) and the assets start being depreciated.